Oil price decline a net positive

Economist Nouriel Roubini says that the sharp drop in oil price is primarily caused by increases in supply, including the increases in production of shale gas and oil in North America and increases in production from the Middle East, including Iran and some unstable countries, such as Iraq and Libya. He believes that the increase in oil supply was significantly underestimated, especially by the International Energy Agency. The oil production decision by Saudi Arabia or the Organisation of Petroleum Exporting Countries (Opec) is, in general, an economic decision and not a geopolitical move against Iran and Russia, Roubini stated. Roubini believes that the impact of lower oil prices on the global economy is ultimately a net positive, as it will facilitate growth and reduce inflation.

According to CFA Institute’s 2015 Middle East Market Sentiment Survey, which offers regional financial insight and assesses forecasted outcomes of some of the region’s most pressing priorities and concerns, the vast majority of respondents (88%) in the UAE believe that the drop in oil prices is not beneficial to the sustainability of the UAE economy. Of respondents based in the UAE, one-third believe that financing for UAE will tighten between $31-40 per barrel, while another one-third believe this would happen at $41-$50 per barrel.

US Showing Robust Growth

Roubini’s assessment approaches the global economy as four engines — the United States, the European Union (EU), Japan, and China. Only the United States is showing robust economic growth, with an estimated GDP growth rate of around 3%. Despite the recent appreciation of the US dollar and anaemic global aggregate demand, Roubini expects the US recovery to continue. The economist believes that the Eurozone is “in trouble” and “just one shock away” from recession and that Japan introduced a consumption tax too soon. China is slowing, with an expected GDP growth of 6.5% this year and around 5.5% next year. Although China realises that it needs to shift its growth model from fixed investment to consumption, the rebalancing of the Chinese economy will be slow.

The difference between economic policy and recovery in the United States compared to the EU is attributed to “[more aggressive] monetary easing, fiscal easing, backstopping, and the recapitalisation [of banks]” in the United States, argued Roubini. EU fiscal stimulus has been a case of too little too late. Roubini clarified that raising taxes and reducing government expenditure is necessary to manage fiscal deficits in the medium term, but in the short term, fiscal austerity has a negative impact on economic growth. He expects the EU to maintain its quantitative easing (QE) against the risk of deflation and the euro to continue falling toward parity to the US dollar.

Six years after the global financial crisis, some economists had wrongly expected that easy money would lead to hyperinflation, a fall in the value of the US dollar, and the rise of gold and bitcoin, claimed Roubini. On the contrary, the US dollar has strengthened, gold is trading way below its highs, and bitcoin was the world’s worst-performing currency in 2014. However, Roubini added, QE is a zero-sum game. In a world where domestic demand is anaemic, amid deleveraging and fiscal drag, countries have been vying for export-led growth by depreciating their currencies. He stated that a depreciation of one currency means a relative appreciation of the other and a trade surplus by one means a trade deficit by the other.

Grexit Too Risky, Too Costly

Roubini strongly believes that Grexit would be a disaster for the Eurozone and will therefore be avoided. Grexit could lead to a run on banks, not just in Greece, but also in some other parts of the Eurozone. Furthermore, dealing with contagion would cost much more than keeping Greece in the Eurozone. The relative size of Greece’s debt and economy are quite small compared to the economy of the Eurozone, and it is not logical to jeopardise the Eurozone because of Greece, he argued. Grexit may also cause Greece to end up in the arms of Russia, just as Russia is becoming more threatening.

-- Writer is Director Islamic Finance & ESG Investing at CFA Institute